Wednesday, 5 October 2011

The impossible trifecta

Kevin Milligan says a Guaranteed Annual Income cannot simultaneously satisfy three goals. Instead, you have to pick two among the following:

low tax rate

high benefit

balanced budget*

Treasury here in New Zealand modelled a GAI for New Zealand on the request of the Welfare Working Group (HT: Lindsay Mitchell). What did they find? A GMI paying $300 per week - the mean benefit income among those on benefits - would cost $44.5 billion, or $52.6 billion if we extended it to superannuitants as a replacement for NZ Super. The former could be covered by a flat personal income tax rate of 45.4%; the latter, 48.6%. But full fiscal neutrality would require tax rates of 50.6% and 54.4% - the lower tax rates would be just enough to cover the transfers, but income tax revenues are currently also used to fund more than just transfers.

If we recognize that most parents are beneficiaries via Working for Families and compensate them for the loss of our version of EITC with a $86 per child per week payment, we get a $57.1 billion fiscal cost and a personal tax rate of 50% (or 55.7% for fiscal neutrality).

And, even this rather expensive system leaves the worst off worse off, as it kinda has to. Treasury notes:

Although the Gini coefficient improves under all models, many beneficiaries (including the disabled, carers and sole parents) currently receive more than $300 per week and would be made financially worse off under a GMI scheme. Therefore the GMIs considered could distribute money away from those most in need of government assistance and toward those who have choices and opportunities but choose not to work.

Treasury also warned about potential adverse labour supply responses to the necessary personal tax rates. And, the induced gap between company and personal tax rates would increase IRD's enforcement costs.

Treasury concludes by reiterating Milligan's impossibility:

From the international examples it is apparent that the more equal a society is in the beginning, the lower the returns to a GMI scheme. That is, a New Zealand specific GMI would either be at a level of income too low to reduce poverty, or a level of income that is high enough to reduce poverty but is therefore expensive and hence distortionary through higher tax rates.

I don't think Gareth Morgan's Big Kahuna scheme is able to escape the trifecta by imposing new taxes on capital or land. Why? Because those aren't free lunches either. If it's worth having a land tax, it's worth doing it regardless of whether we have a GAI. So in the first stage we set the optimal tax structure - and I'm completely unconvinced that a capital gains tax is all that hot an idea anyway (see Seamus's posts herehere and here.) But whatever the optimal tax structure, we implement it in stage one. Then, we still have to increase all the tax rates by enough to pay for a GAI if we're going to have a GAI. And the impossibility reasserts itself.

Morgan squares things with a cheaper GAI paying $11k instead of Treasury's $15k. But I have a hard time believing that's a stable political equilibrium. Could NZ politicos really avoid the temptation of adding targeted benefits for the many folks currently on benefits totalling well over $15k? If not, how quickly do we wind up having a GAI on top of a targeted benefit system?

* Update: Milligan's updated this in a more recent tweet. I think there are a few possible impossibilities here.

1 comment:

Very interesting--thanks for the link to the NZ GAI paper. The core of the problem is that under GAI you are giving a lot of transfers to people who currently aren't getting any. (That would be those who work but are lower earners.) Where does that money come from? Maybe it's good to transfer more to the 'working poor', but it is hard to get that done without spending more money.